Risky `junk' bonds got that name for a reason

Money Talk

Your Money

July 25, 2004|By MATT LUBANKO

I have periodically bought high-yield or "junk" bonds and done nicely with them. Aside from BondsOnline (www.bondsonline.com), can you give me suggestions for sites that list junk bonds I can purchase without going through a full-service broker?

- N.S., Chicago

Try the Web site of Bond Pickers (www.bondpickers.com). Also try an online search using "high-yield bond offerings" as your key words. High-yield bonds are those rated below Triple B minus by Standard & Poor's, or below Baa3 by Moody's; they are "speculative grade" as opposed to "investment grade."

After you learn the letter grade of a prospective bond, dig a little further before you buy any high-yield corporate debt. Learn about the risks you face. Try to figure out how to minimize your exposure to unnecessary risk, if that's possible. Above all, try to take the steps necessary to ensure that you won't lose your shirt; junk bonds can deliver whopping losses - all in pursuit of returns that will never make you fabulously rich.

"On a bond-by-bond basis, you are getting equity-like risk for relatively modest returns," said Timothy L. Rabe, manager of the Delaware High Yield Opportunity Fund.

To learn more about risk, visit the DefaultRisk.com (www.defaultrisk.com) Web site; many papers on the site are highly technical. Read Investing in Junk Bonds: Inside the HighYield Debt Market, by Edward Altman and Scot Nammacher (Beard Books, $34.95) for a useful overview of junk bonds. Also do a Google search with "default rates and corporate bonds" as your topic lead.

An annual white paper from Moody's Investors Service titled "Historical Default Rates of Corporate Bond Issuers" is particularly helpful. Within that paper there is a chart labeled: "Average Cumulative Default Rates by Letter Rating." This one chart speaks volumes: Bonds rated Baa (low-grade investment grade) have historic default rates of 1.95 percent if they mature in five years; bonds rated Ba have historic default rates of 11.42 percent if they mature in five years; and bonds rated single-B, with five years to maturity, have default rates of 31 percent.

Reviews of history are not previews of the future. But if history repeats itself, ask yourself how well you'd sleep knowing the single-B-rated corporate bond you buy now has nearly a one-in-three chance of going into default by 2009. Dillard's Inc., Northwest Airlines Inc. and Lucent Technologies Inc. are among the many companies with single-B ratings.

Along with default rates, learn about recovery rates: how many pennies on the dollar bondholders receive after their company goes into default. A retail company, according to past data, typically pays just 15 cents to 20 cents on the dollar of its debt in default. Oil companies, by contrast, pay anywhere from 35 cents to 40 cents on their bonds that go bust. Can you endure such losses in pursuit of annual yields below 15 percent or even 10 percent?

Along with reviewing worst-case scenarios, consider taking preventive measures. Is your company profitable? Can you realistically expect it to be profitable within three to six months? Can this company's cash and cash equivalents cover one year's interest expense? Do current assets exceed current liabilities by a 1.5-to-1 ratio (a pretty good sign)? Is the company's "coverage ratio" - earnings before interest and taxes divided by annual interest expense - 1.5 or greater (another pretty good sign)?

And finally, are you absolutely sure you'll be able to hold this junk bond until it matures? "Even if there is concern about possible default, if you're forced to sell a bond before it matures, you could get far less than what you paid for it," said an economist with Wrightson ICAP LLC, a N.J. bond research firm.

Furthermore, longer-term junk bonds rarely mature. "They are either called by the creditor or the company files for bankruptcy," Rabe said.

Where can I learn more about finding a fee-only financial planner? I don't want to pay commissions for products I buy. I just want to pay an hourly fee, or pay flat fees for specific services.

- Q.M., West Hartford, Conn.

Two online resources might help you find a fee-only financial planner in your area. Visit the National Association of Personal Finance Advisors Web site at www.napfa.org or the Garrett Planning Network Inc. site, www.garrettplanningnetwork.com.

Some fee-only financial planners charge by the hour. Some charge flat fees for specific services. Others charge a percentage-based fee on the assets they manage for you. "They differ from other firms in that they do not charge referral fees or depend on commissions from the products they sell," said Julie Schatz, of Investor's Capital Management, a fee-only firm in Menlo Park, Calif.

Where can I learn more about Tortoise Energy Infrastructure Corp.? You mentioned this closed-end mutual fund in your June 20 column.